We here at Mytwocent$ would like to ask you all to please put your hands together in a big round of applause for Silicon Valley Bank (SVB). They are the latest recipient of the highly coveted modern-day badge of honor known as - The Participation Trophy. Let’s be honest here; they deserve it, as they tried - they really tried.
In all seriousness, though…
An MBA from an accredited University should bring with it some knowledge of how the business world functions. It should allow the graduate to make financial decisions at a much higher level, with a far greater degree of both accuracy and understanding than that of, say, an average high school graduate. Unfortunately, this just isn’t the case. Based on the collapse this past week of SVB, whose management team is littered with MBAs, it seems the only thing an MBA brings to the table is a predisposition toward stupidity coupled with unparalleled hubris.
Borrow Long & Lend Short …AKA…. “The logical way”
To fully comprehend why SVB collapsed, Bagholder would ask you to imagine your favorite Rock Band will be doing a few shows this upcoming weekend at a local arena. Your brother-in-law was able to get the exclusive right from the band to sell T-shirts at the venue for a cost of 5k. He invites you into the deal as an equal partner, provided you pay the wholesale cost to produce 2000 shirts at $2.50 each - also 5k. The plan is to sell the T-shirts for $25, which by today’s standards, is cheap. Should they sell out, the partnership would take in 50k, which gets you 25k for your half. It’s a no-brainer deal; the only problem being you don’t have the 5k in seed money. After exhausting all other avenues to get the scratch, you head down to the “Big Guy’s” social club/mafia hangout and talk to a loan shark. He tells you he will give you the 5k, but you have to pay him back 6k in 30 days, or he will take a crowbar and lever off one of your kneecaps. Fortunately, the concert was this weekend, and the T-shirts sold like hotcakes, so there was no problem getting the Big Guy his money back in time.
In this fictional example, you borrowed long-term (30 days) and lent to the partnership short-term (this weekend). Borrowing long & lending short is the only way the business could succeed, allowing everyone involved to make money. A win-win for everyone. It doesn’t take a Harvard MBA to figure out what would happen in our example had the timelines been reversed. If you had borrowed short term requiring you to pay back the Big Guy this weekend and lent long with the concert a month away - you would be, at a minimum, minus one kneecap.
Borrow Short & Lend Long …AKA… “The MBA way”
It may seem hard to believe, but the business model of every bank on the planet is to do the complete opposite of what we did in our fictional example. Yeah, they borrow short & lend long. SVB collapsed into bankruptcy this past week precisely because they did just that. They borrowed (short) their depositor’s money and lent (long) to the government by purchasing 30-year treasuries. Consequently, when the depositors requested their money back, SVB couldn’t produce it, because it was all tied up long-term. It’s difficult to blame the corporate suits at SVB for their idiocy, because they were doing precisely what they had been taught to do by the universities which gave them their MBAs in the first place. Only in the fantasy land of academia would the idea of borrowing short & lending long seem like a reasonable business model. Sure, it can work for a while in a falling interest rate environment, but in the real world, it eventually gets you kneecapped.
The suits at SVB are not entirely without blame. Their management team decided locking up customers’ money at historically low interest rates was a good idea. The 30-year bonds they purchased had an average yield of 1.55%. To put that in proper perspective, notice how the Big Guy loaned out 5k expecting to get back 1k interest in a month…. In sharp contrast, the suits at SVB loaned out the same 5k (about 18 million times over), locking in a monthly interest payment of $6.46 per 5k. As if that’s not bad enough, they compounded their stupidity by locking in that trade for 30 years! Can you imagine taking on the risk of loaning someone 5k only to have them hand you $6.46 monthly? Who does that?? It takes a special mix of arrogance and stupidity, which apparently comes with an Ivy League MBA, to lock up money that long for such a meager return.
It really shouldn’t be a surprise how a boardroom full of MBA’s s could get things so ass-backward as to borrow short & lend long. After all, they were indoctrinated by top universities, who also have a completely ass-backward business model. Think about it … Universities provide lessons, and then test on those lessons. In life, the test comes first, the lessons second. Bag is blessed to have never been infected with the MBA Virus. Nope, everything Bag knows about business was learned in the real world, where good decisions are rewarded, and foolish decisions are punished. Bag has made his share of both, granting him a natural immunity to the MBA Virus.
Spreading Moral Hazard …
In true idiotic fashion, the Biden administration is doing everything possible to remove the lesson-producing incentives of reward & punishment by choosing to bail out SVB from the poor decisions made by their senior management. They could have just liquidated the bank’s bond portfolio at its current market value, which would have left depositors taking a (roughly) 50% loss on their deposits. The sting of that loss would have incentivized depositors everywhere to be more diligent and bankers everywhere to be more cautious. Instead, the Feds opted to parlay the losses of SVB into even bigger losses down the road by deciding to buy back the bonds at their original purchase price, further conditioning the sheep depositors not to worry. Going forward, anytime a corporate suit at some other bank is considering whether to gamble with customer deposits, they needn’t worry, as a precedent has been set. The moral hazard Biden’s administration is currently spreading in the SVB case effectively gives bankers a license to gamble, and gamble they will.
The worst part of the whole SVB saga is they are just the first domino. Any bank with a business model of borrow short & lend long, which is to say ALL BANKS …. are on borrowed time. They are ALL bankrupt, no exceptions. Bag pointed this out last month, before the first domino fell (link here). They all have customer deposits tied up in long-term bonds. If any bank tried to sell those bonds in the secondary market to raise cash & meet customer demand for their money, not only would they have to book massive losses (due to rising interest rates), but thanks to the haircuts, they don’t have enough bonds to sell. Just look at the balance sheet of any publically owned bank. They are all sitting on huge losses in their bond portfolios. But, they do possess a license to gamble…so you can expect the risks they will take going forward will increase as they chase those losses. Ever met a gambler who wasn’t trying to get even? This can only end one way, with more fallen dominoes. In fact, Bag can see the next domino already; it reads….”Credit Suisse”…
This whole saga brings to mind the George Orwell quote from his novel 1984: “Some ideas are so absurd, only an intellectual could believe them.” Bag is certain even the great Thornton Mellon (from the clip below) would tell you: Borrowing short & lending long is one of those ideas.
That movie clip was well cast, nobody’s more arrogant than an Englishman.
Fantasy Land for reals!